Q&A: Libor, how it was manipulated and how it affects mortgages and savings

The City regulator has ordered its biggest ever fine - a £290million penalty for Barclays - for manipulating the key lending rate of Libor.[read more]We explain why this interest rate is so important to your finances.

WHAT IS LIBOR?It
stands for the London Inter-Bank Offered Rate and is the interest banks
charge to borrow from each other. Banks rely on this money to lend to
customers and businesses. Its equivalent in Europe is called Euribor.

Pugh on the Barclays bank LIBOR scandal

HOW DOES IT AFFECT ME, MY MORTGAGE AND MY SAVINGS? The
rate banks pay to raise money affects how much they charge on loans and
mortgages. An increase in Libor can add hundreds of pounds to
households’ annual mortgage repayments or a loan to a small business.

This
was seen with dramatic effect in the run up to the financial crisis,
when Libor soared and lenders raised their rates. It is also used as the
benchmark for trillions of pounds in complex financial investments.

It also influences savings rates. If banks can borrow more cheaply from each other then they don't need to offer such good returns to savers.

WHAT DOES IT REFLECT?

Libor became a focus of attention in the credit crunch because it reflects the confidence that banks place in one another - hence one of the reasons banks would want to artificially influence it.

The three-month sterling Libor rate
- the key rate for the UK - should be just 10 or 20 basis points higher than the bank rate in normal conditions. Pre-credit crunch, if the bank rate or base rate was
2 per cent, Libor would be 2.1 per cent or 2.2 per cent. But it soared far higher in August
2007, marking the start of the credit crunch. It spiked even higher during the collapse of Lehman Brothers in September 2008 but then fell as banks were rescued by taxpayers and the cost of borrowing slashed by the Bank of England.

How the LIBOR rate has moved in the past year | Source: Bloomberg

Three-month
sterling LIBOR from 2006 to 2012: The rate broadly runs in line with
the UK base rate except for the crunch period in 2008 and in recent
months

Sorry: Chief executive Bob Diamond apologised for the incident and will forgo his bonus this year

HOW IS IT SET?
The rate is set every morning, at around 11am, by a panel of banks and overseen by trade
body the British Bankers’ Association. Each bank sets the rates at which
it believes it can borrow, from overnight to 12 months. There are 150
Libor rates, spanning ten currencies and 15 time periods.

More...

WHAT HAS BARCLAYS BEEN DOING?
Barclays’ traders speculating on movements in interest rates were manipulating Libor in an effort to make huge profits.

Its traders were conspiring with the
‘submitters’ at the bank which lodge their Libor rates every morning.
Depending on the way they were betting, traders would urge these
submitters to increase the Libor rate or lower it.

Barclays’ traders also conspired with
ex-employees working at other banks to try to influence their Libor
submissions. During the financial crisis Barclays also fiddled the
figures to dupe the market into thinking it was more financially sound
than it was.

Libor is often seen as a barometer of
how healthy a bank is. Just as customers with bad credit records have
to pay higher interest rates, banks which are deemed in poor financial
health are charged more to borrow. Barclays became anxious that its
Libor rate was higher than many of its peers and that they were fiddling
the figures. It decided to join the party.

ARE ANY OTHER BANKS DOING THIS?
It is likely this is just the tip of the iceberg. Barclays is just the first to get caught.

For the last two years a dozen
regulators on three continents have been combing through the files of
more than 20 banks involved in the rate setting process.

Swiss bank UBS is understood to have
already suspended a number of traders. Royal Bank of Scotland, Lloyds,
and HSBC yesterday said they were helping the Financial Services
Authority with its enquiries.

CAN BARCLAYS CUSTOMERS - OR THOSE OF OTHER BANKS - CLAIM COMPENSATION?

It'stoo early to say. If it has pushed up Libor at times, then it will have made new tracker mortgages more expensive than they would otherwise have been - fixed-rate pricing is more influenced by 'swaps' markets. If the price was pushed down then it would have influenced the savings market, dragging down the rates on offer.

However, determining whether individuals have been directly affected will be very difficult. We at This is Money will be looking at this in more detail today and we'll publish our conclusions on this site later today.

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